Challenging summit ahead

On the eve of a crucial EU summit in Brussels, German Chancellor Angela Merkel and French President Nicolas Sarkozy have urged wide-ranging European treaty changes to enforce greater budget discipline in the eurozone.

"We are convinced that we must act immediately," the leaders said on Wednesday in a joint letter to Council President Herman Van Rompuy outlining their plan to save the eurozone.

The plans include a new EU framework to speed up progress toward a common corporate tax base and a financial transaction tax as well as convergence of policies affecting financial regulation and labor markets.

"A new common legal framework, fully consistent with the internal market, should be established to allow for faster progress in specific areas," the letter said. "The current crisis has mercilessly uncovered the deficiencies in the construction of the European Monetary Union."

Greater cooperation

Merkel and Sarkozy also urged "automatic consequences" for eurozone members with deficits exceeding 3 percent of gross domestic product, and called for euro summits to be held twice a year, as well as monthly meetings, while the crisis lasts.

Scrambling to resolve the eurozone's debt crisis ahead of the summit, officials in Brussels have been looking at ways to create a rescue fund that would be able support large eurozone economies such as Italy, Spain and France: A financial firewall that would prevent the debt crisis from hitting the heart of the eurozone.

At the last such summit six weeks ago, EU leaders had agreed to boost the temporary bailout fund EFSF to one trillion euros ($1.33 trillion). The project has not taken off yet because private investors have shied away from participating. Concrete figures have not been posted, but it seems clear that the EFSF will contain no more than 500 billion euros, half the amount projected.

Officials in Brussels are now looking at launching the European Stability Mechanism (ESM), the permanent structure that was to be launched as a replacement for the EFSF, sooner than previously planned: at the end of 2012, and equipped with about 500 billion euros in lending power. The EFSF would not be dissolved - in effect, there would be two rescue funds working alongside one another with combined financial 'firepower.'

Spotlight on the ECB

The ESM could become a bank able to lend unlimited amounts from the European Central Bank (ECB). The upcoming summit will only make a difference if leaders agree on a fiscal union as well as giving the ECB more responsibility, Thomas Straubhaar, head of the Hamburg Institute of International Economics (HWWI), said. "The ECB is independent - but will have to play a more important role than previously planned," he told Deutsche Welle.

The ECB is already buying up debt from distressed eurozone states, but it is reluctant to step up its intervention because that would be against EU laws and because of looming inflation.

The ECB also sees the threat of a 'moral hazard,' said Guntram Wolff of the Brussels-based Bruegel think tank: The bank fears that stepping up its role would take pressure off governments to fix their finances. As a result, Wolff said, the ECB is not likely to get involved in a massive rescue mission until the eurozone introduces a fiscal union with tough rules.

IMF participation

The International Monetary Fund (IMF) could function as the third rescue-plan pillar in combination with the EFSF and the ESM. In this case, individual eurozone central banks would lend the IMF money.

The IMF would in turn lend these funds to debt-strapped eurozone members. National central banks could borrow money from the ECB. The IMF detour would allow funds from Europe to be redistributed in Europe.

Should the confidence crisis worsen, and should Italy, for instance, no longer be able to finance its debt, the ECB would have to intervene because it is an EU institution that can act more speedily than others, according to Guntram Wolff.

"In the end, the ECB won't have much of a choice. It will have to intervene because the system is so frail already. Non-intervention would lead to financial collapse," he said.

Regain confidence

Officially, French President Nicolas Sarkozy and German Chancellor Angela Merkel stress the ECB's independence. The German government and the Bundesbank - Germany's central bank - reject all manner of direct debt financing by the ECB.

While observers expect German resolve to weaken in view of the extent of the eurozone crisis, Finance Minister Wolfgang Schäuble has underlined Germany's opposition to yet another rescue option: introducing eurobonds.

"You can't put the cart before the horse, that doesn't make any sense," he said. "The eurobonds debate is easily misunderstood as taking the pressure off countries that need to cut their budget deficit," Schäuble told German public television.

"Right now, every state must solve its own problems and we must create common institutions that guarantee confidence in the euro," he said. "Everything that detracts from that is harmful."

Author: Bernd Riegert / db (dpa, Reuters)
Editor: Andreas Illmer